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Trustee covenant demands

We have noticed in a couple of recent transactions that trustees (or at least their advisers) are demanding more in the way of monitoring obligations, restrictive covenants and negative pledges when negotiating covenant support packages.

Typically trustees and companies looking at a difficult actuarial valuation process might seek to agree a package of measures which supports the covenant, allows less conservative assumptions and reduces the cash contributions that might otherwise have to be paid into the scheme. But it seems it is no longer enough that all sides proceed on the basis of a particular covenant analysis and negotiate and agree a funding package which reflects that analysis. Some trustees are being advised that they must diligence the covenant analysis and take proactive steps to restrict the company such that the analysis remains valid.

Initially, this might have taken the form of a few information covenants and a negative pledge that the trustees would always rank pari passu with bank debt. In recent months, we have seen examples where trustees are asking for restrictions on financial ratios (for example a maximum debt/asset value), periodic monitoring of those ratios, the maintenance of minimum credit ratings for the company with dividend lock ups or letters of credit if the rating is breached, restrictions on related party transactions, and the ring fencing of the covenant supporting group companies. These are all restrictions which might be associated with the more leveraged end of the finance world; but we are seeing them demanded in some quite inappropriate situations in the pensions sphere. In many situations, these restrictions are counterproductive to the company's ability to react quickly to market conditions and continue to grow and therefore support its pension scheme.

As ever, the only way to deal with such suggestions is to ensure that issues and risks are fully understood and discussed openly by both sides. Only then can trustees determine whether restrictions are actually necessary and whether they could be counterproductive. Only then can companies determine whether there are particular risks that are rightfully important to the trustees and start to work out ways to address those risks.

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